While 401(k) plans are the sole retirement plan savings vehicle for over 40 million participants -- and an essential benefit for small and mid-sized companies -- many employers offer them without being fully aware of the responsibility and potential liability that accompanies 401(k) plans.

With 2002 a record year for new civil suits -- over 11,000 -- lawyers see an opportunity for litigation that "will be bigger than tobacco." While the giant Enrons grab headlines, most litigation involves smaller companies.

The Next Litigation Battleground?
Several factors have come together to increase the potential for litigation:

• The deepest bear market since the Great Depression is increasing scrutiny of how companies choose and oversee investments and the fees they pay for plan-related services.
• Small and mid-sized corporations often rely on their vendor for plan and investment oversight -- an approach fraught with potential conflicts of interest.
• Baby Boomers, and others, are finding that they may not have the money they expected to have when they are ready to retire.
• The Employee Retirement Income Security Act (ERISA) is one of the most complicated areas of federal law, and much of it is still being defined through the courts and regulatory action.
• Plan sponsors don't understand what they are required to do; the Department of Labor (DOL) estimates that 75 percent of all plans are out of compliance.

Possible Areas of Litigation
Litigation in the next few years is likely to focus on areas that have a high impact on participants' balances. Listed below are some of the critical areas of required plan sponsor oversight that are likely to be the vanguard of future litigation.

• Exclusive Benefit. ERISA Sections 403(c) and 404(a)(1)(A) say that failure to operate the plan for the exclusive benefit of participants can result in personal as well as corporate liability. Plan assets cannot benefit the employer and expenses paid by the plan must be reasonable.
• Vendor Selection. Selecting vendors is a fiduciary act according to the DOL's Advisory Council on Employee Welfare and Pension Benefit Plans. Employers who don't use a rigorous search process increase their liability.
• Selecting Investment Options. Choosing investments is also a fiduciary duty under ERISA Section 404(a) (1)(B). Employers must follow the "Prudent Expert Rule" by acting with the skill, prudence and diligence of a prudent man with knowledge of such matters. As the courts made clear in Donovan v. Cunningham, "a pure heart and an empty head are not enough" to meet the prudence standard.
• Investment Monitoring. Fiduciaries must monitor investment choices on an ongoing basis to ensure that they remain suitable for the plan. Delegating oversight to the vendor puts the participants of the plan at risk, according to the DOL.
• Monitoring Fees and Expenses. Fiduciaries have a duty to monitor fees and expenses. Investment fees represent 80 percent or more of total 401(k) plan fees. Plans with higher than average fees will produce less money for participants when they retire.
• Monitoring Other Plan Functions. Day-to-day operational aspects of the plan are not fiduciary acts, but monitoring them is. The plan sponsor, not the vendor, is charged with oversight to ensure the plan is operated correctly.
  

Limiting and Mitigating Liability
Limiting liability begins with establishing a clear, documented process of decision-making and oversight. Process, not results, demonstrates that you have acted in the best interests of participants. Failure to adequately document the process removes the best line of defense. Follow these steps:

1. Establish a committee to oversee the plan. The governance mandate of the committee should be established through a board resolution and should specify how often the committee will meet. Identify specific titles or roles within the company to serve on the committee rather than simply appoint individuals, and report to the board of directors annually.
2. Perform a gap analysis to determine areas of oversight that need improvement. If you suspect substantial gaps, contact an ERISA attorney to discuss how to proceed without exposing the fiduciaries to further risk by creating a document that could be used by plaintiff's counsel later.
3. Implement a written Investment Policy Statement (IPS) that provides a clear road map of how investment decisions are made, investments monitored and, if need be, replaced. The policy should be detailed enough so that someone reviewing investment decisions years later would understand the decisions that were make and why.
4. Review plan investments quarterly. Document that funds meet or exceed IPS standards, and what you have done to understand underperformance. If a fund continues to under-perform, replace it.
5. Ensure that plan fees (including investment and other asset-based fees) are reasonable for plans of similar size and complexity. Get independent comparisons annually.
6. Conduct periodic, limited scope audits of key operational elements of the plan. Keep committee minutes to document discussions and provide a paper trail.
   

Other actions that require attention:

• Avoid prohibited transactions.
  Duties of company officers and plan fiduciaries can come into conflict, particularly where company stock is involved. When in doubt, contact an ERISA attorney before you act.
  
  Make contributions at the same time you do payroll. The courts have construed holding employee contributions even a few days as a loan to the employer -- and a prohibited transaction. This is one of the most common mistakes made by companies today and a red flag for the DOL.
  
  
• Insure your risk.
  Successfully defending a lawsuit often costs hundreds of thousands of dollars. Review what is and is not covered with your consultant or counsel.
  
  Hire an independent third party to oversee investments and monitor investment expense. Ask them to be a named fiduciary. This is particularly important for bundled plans where the vendor's profitability depends on which funds are chosen for the plan.
  
  
• Communicate with participants.
  Avoid putting the plan on autopilot once it is up and running. Frequent communication builds trust.
  
  
• Listen to participants. Communication should go two ways. Understanding their likes and dislikes about the plan and investments allows you to address concerns early on, so the first person you hear from isn't a plaintiff's lawyer.

DONALD STONE (dstone@plansponsoradvisors.com) is a founder and principal with Chicago-based Plan Sponsor Advisors, which specializes in helping small and mid-sized companies oversee all types of retirement plans, including 401(k) and defined benefit.

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FEI's flagship publication, Financial Executive magazine, has won another award -- an Eastern Regional gold (first place) award from the American Society of Business Press Editors (ASBPE) in their annual competition. FE won in the editorial division for its March 2002 special section on "Best Practices." This is the fourth juried award FE has won in the past two years. The award was presented in Boston on Monday, June 9.